Insights into Editorial: Are fiscal risks increasing?

The Fiscal Responsibility and Budget Management (FRBM) Act was enacted in 2003 which set targets for the government to reduce fiscal deficits. The targets were breached time and again.

Finance Minister deferred the fiscal deficit target of 3.2% due to several factors such as low GST collections, spike in oil prices and pressure to spend more.

Background: Why FRBM became necessary?

The financial health of the government was eroded by excessive government borrowing and its resultant debts. High revenue deficit due to higher expenditure on subsidies, salaries, defence etc. compelled the government to make big borrowing.

The borrowing again produced high interest payments. Interest payments became the largest expenditure item of the government.

The Government introduced FRBM Act, 2003 to check the deteriorating fiscal situation.

The main purpose was to eliminate revenue deficit of the country and bring down the fiscal deficit to a manageable 3% of the GDP by March 2008. Fiscal deficit occurs when the government’s expenditure outgrows its revenues.

However, the deadlines for the implementation of the targets in the act were postponed due to the 2007 international financial crisis and later it was suspended.

In later amendments, Concept of Effective Revenue Deficit was introduced and additional Medium-term Expenditure Framework” statement should be prepared by government and laid before both Houses of Parliament.

In Budget 2016-17, a panel under the chairmanship of N.K Singh was constituted to review the Fiscal Responsibility and Budget Management Act.

What are the main recommendations of NK Singh committee?

Committee recommended that the combined debt-to-GDP ratio of Centre and States should be brought down to 60% by 2023(40% Centre and 20 % States) as against existing 49.4% of centre and 21% of states.

For fiscal consolidation, the centre should reduce its fiscal deficit from the current 3.5% (2017) to 2.5% by 2023.

The central government should reduce its revenue deficit steadily by 0.25 percentage (of GDP) points each year, to reach 0.8% by 2023.

The committee has recommended an Escape Clause to accommodate counter cyclical fluctuations such as Boom or Recession or in case of any natural calamities.

The Committee proposed to create an autonomous Fiscal Council with a role of preparing multi-year fiscal forecasts, recommending changes to the fiscal strategy, improving quality of fiscal data, advising the government if conditions exist to deviate from the fiscal target, and advising the government to take corrective action for non-compliance with the Bill.

What are the proposed changes to FRBM Act in the Budget 2018-19?

Missing the fiscal responsibility targets year after year and changing the statutory framework time and again has been a concern to fiscal discipline.

Budget 2018-19 has proposed amending the FRBM Act again, which will shift the target of 3% fiscal deficit-GDP ratio to end-March 2021. No target has been set for revenue deficit and combined and central debt-GDP ratios are to be reduced to 60% and 40% of GDP by 2024-25.

The current Budget has retained the fiscal deficit at 3.5% of GDP, missing the budgeted target of 3.2% which was itself a deviation from the stipulated target of 3% for 2017-18 in the amended FRBM Act.

In the absence of improvement in the fiscal deficit level in 2017-18, the debt-GDP ratio has increased to 49.1% in 2017-18 from 48.7% in 2016-17 rather than falling.

The NK Singh committee had recommended a target at which the fiscal deficit to GDP ratio was to be stabilised set at 2.5%. The government apparently did not accept this framework and continued with the 3% target. However, government has to abide by this 3% mandate beyond 2020-21 to bring down debt to GDP ratio to 40% by 20124-25.

The committee had specified a revenue deficit glide path, reaching 0.8% by 2022-23. This too was not accepted. Unless government dis-savings are eliminated, it will be difficult to reverse the trend of a falling savings rate.

The Central government did not accept the recommendation of setting up a fiscal council.

Higher reliance on extra budgetary resources may lead to Fiscal risks

Fiscal risks may be higher with the reliance on extra-budgetary resources for financing a number of ambitious government spending programmes.

In the Budget for 2018-19, the total outlays for three focus areas, namely, agriculture and rural livelihoods, infrastructure and education, and health and social sectors, amount to 11.6% of GDP.

These are to be funded using budgetary and extra-budgetary resources. Budgetary resources constitute only 16.4% of the total outlay. The balance, 83.6%, is to be raised as an extra-budgetary resource by the public sector enterprises concerned, special purpose vehicles and other similar institutions.

Any dependence on borrowing for these extra-budgetary resources while the saving rate is falling can put considerable pressure on interest rates.

Another year of slippage can be damaging. Interest payments to revenue receipts of the Centre stand at 35.3%. This restricts the space for other development expenditures.

Way Forward

The fiscal rules adopted by government have generally not been followed by the Central Government, especially after 2008 mainly because of the global crisis.

In this context, an important question is whether there is need for stiff fiscal rules and should these be adhered strictly or prudently in the welfare of the society.

In view of the changing circumstances in the economy, probably, there is a need for a regular and constant review of the fiscal policy and targets contained in FRBM, as circumstances can change in the economy.

There is need to have transparency in macroeconomic forecasting on the basis of which growth rates are projected as well as different types of deficits are computed in the Union budget.

Budget deficits should not only be confined to a single year computation but preferably balanced over a medium term. Therefore, the Government should consider a medium-term framework for fiscal policy and ensure that over the medium term targets are met.

In the FRBM, the Golden Rule of revenue neutral, preferably surplus, should be strictly followed.

To achieve fiscal discipline and meet targets there is need to raise tax to GDP ratio. The use of technology can be considered to ensure effective and efficient tax collection. The current drive of adopting GST and digitalizing India can help in higher tax collections.

Interest payments obstruct a substantial part of revenue receipts. Given the limitations of enhancing tax collection, the Government increasingly resorts to borrowing. Therefore, there is a need to rationalize interest expenditure of the Central Government.